Beware Conflicts When You Hire Board Members’ Companies-Part 1

Our experts universally say yes, with the proper disclosures–but that it may not be wise because of potential and perceived conflicts. In this two-article series, we provide a rundown. Here in Part 1, we discuss the hoops you must go through to hire board members and their companies. In Part 2, we discuss whether those hoops are worth the effort.

Hiring Board Members a Common Dilemma

“This comes up continuously,” says Elizabeth White, a shareholder and head of the community associations practice at the law firm of LeClairRyan in Williamsburg, Va. “Often boards think it’s a really good idea. The board member thinks he or she’s providing valuable information, and the rest of the board may think so, too, unless somebody pops up and asks some questions. Before you get to the question of ‘Should you hire a board member?’ the question is ‘Can you?'”

Typically, it’s permissible to hire a company owned by a board member, or at which a board member is employed. White explains, “Associations are going to be held to the business judgment rule, which essentially asks: What would a prudent business person do under similar circumstances?”

“In many states, the rule has been codified in the nonstock corporation act [which applies to nonprofit corporations, like associations],” continues White. “Virginia has adopted the model act, so lots of states have acts comparable to ours. In Virginia, you have to go through a series of questions and analysis to determine if a transaction is voidable because it’s a conflicted transaction.”

Generally, that analysis goes like this:

1. Was there full disclosure?

“Obviously the board member would want to make full disclosure at a time that’s meaningful, saying something like, ‘I’m a principal or employee in this company,'” explains White.

2. Did the board member recuse himself?

“The board member should leave the room when the discussion and vote over the contract takes place,” explains Robert Galvin, a partner at Davis, Malm & D’Agostine PC in Boston who specializes in representing condos and co-ops. “He should say, ‘Call me when the discussion and vote is over,’ and he should ask that his request be in the minutes to protect himself. He’d want it to be in the minutes that he made full disclosure and wasn’t part of the discussion or vote.”

3. Is the contract fair?

“Whatever the deal is,” says White, “it needs to be fair to the association.”

If those rules aren’t followed, the board may be able to undo any contract entered into with the board member’s company. “In many states, you can unravel a conflict of interest transaction if the deal isn’t fair to the association,” says White. “Without that full and complete disclosure, the transaction can also be invalidated as a conflict of interest transaction. It can also often mean the board member has violated conflict-of-interest laws, and some states look at that as a breach of fiduciary duty.”

While you’re dealing with legal considerations, don’t forget practical considerations, too. “Maybe you have a board member who owns a landscape company,” explains James R. McCormick Jr., a partner at Peters & Freedman LLP in Encinitas, Calif., who represents associations. One protective step you can take is, “if proposals are submitted, the board member shouldn’t see those other proposals before his is submitted.”

Now you know that you can hire board members and their companies. The bigger question is: Should you? To understand the risks you take, see the second installment of our 2-part series, Beware Conflicts When You Hire Board Members’ Companies–Part 2.

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